Tax and Budget December 2011

INVESTING IN THE FUTURE

MAKING THE SEVERANCE TAX STRONGER FOR WEST VIRGINIA About the Author

Sean O’Leary is a Policy Analyst with the West Virginia Center on Budget and Policy.

Acknowledgments

The West Virginia Center on Budget and Policy would like to acknowledge Downstream Strategies for their technical support with this topic.

The author thanks Ted Boettner, the Executive Director of the West Virginia Center on Budget and Policy, for his input and suggestions. Thanks also go to Linda Frame for editing the report.

Layout by Elizabeth Paulhus.

This report was supported by generous grants from the W.K. Kellogg Foundation, the Claude Worthington Benedum Foundation, and the Mary Reynolds Babcock Foundation. Table of Contents

Executive Summary 3

Introduction 4

Section One West Virginia’s Severance Tax 6 Revenue Sources for Severance Tax 6 Severance Tax Rates 7 Severance Taxes in Other States 8 Where the Severance Tax Is Invested 8 Infrastructure Fund 8 Tax Department Administration 8 Division of Forestry 9 Local Dedication 9 General Revenue 11

Section Two How the Severance Tax Is Invested 12 Natural Gas and Oil Local Use 12 Coal Local Use 13

Section Three The Impact of Severance Taxes 15 Evaluation in Other States 15 The Impact of the Severance Tax Is Small 16 Who Really Pays the Severance Tax? 18 What Is the Full Impact of the Severance Tax? 18

Section Four The Future of West Virginia’s Severance Tax 19 The Declining Contribution of Coal, the Rising Contribution of 19 Natural Gas The Future Composition of the Severance Tax 20

Section Five Conclusion 22 Policy Recommendations 22

Endnotes 23

West Virginia Center on Budget & Policy 1 List of Figures

Figure 1. Sources of Severance Tax Revenue, FY 2011 6 Figure 2. Value of Reduced Severance Tax Rate for Thin Seam Coal 7 Figure 3. Severance Tax Distribution, FY 2011 8 Figure 4. Estimated General Revenue by Source, FY 2012 11 Figure 5. General Revenue Growing More Reliant on Severance Tax Revenue 11 Figure 6. Estimated General Revenue Expenditures, FY 2012 12 Figure 7. Natural Resource Industries Have Below-Average Tax Burdens 17 Figure 8. West Virginia’s Severance Tax Has No Obvious Impact on Wage Growth 18 Figure 9. Projected Decline of West Virginia Coal Production 19 Figure 10. Booming Natural Gas Production in West Virginia 19 Figure 11. The Future of West Virginia’s Severance Tax 20 Figure 12. Changes to Severance Tax Local Dedication 20

Table 1. Top Severance Tax States, 2010 5 Table 2. West Virginia Statutory Severance Tax Rates 7 Table 3. Effective Severance Tax Rates for Top Severance States, 2007 8 Table 4. County Expenditures of Oil and Natural Gas Severance Tax Revenue, 12 FY 2011 Table 5. Municipal Expenditures of Oil and Natural Gas Severance Tax Revenue, 13 FY 2011 Table 6. County Expenditures of Coal Severance Tax Revenue, FY 2011 13 Table 7. Most Popular County Line Item Expenditures of Coal Severance Tax 13 Revenue, FY 2011 Table 8. Largest Line Item Total County Expenditures of Coal Severance Tax 13 Revenue, FY 2011 Table 9. Municipal Expenditures of Coal Severance Tax Revenue, FY 2011 14 Table 10. Most Popular Municipal Line Item Expenditures of Coal Severance Tax 14 Revenue, FY 2011 Table 11. Largest Line Item Total Municipal Expenditures of Coal Severance Tax 14 Revenue, FY 2011 Table 12. Simulated Tax Incentive Scenarios for Wyoming Severance Tax 15 Table 13. Wyoming’s Higher Tax Climate Did Not Discourage Natural Gas 16 Production Table 14. High Business Taxes Not Related to High Business Costs 17

Map 1. Coal Revenue Distribution, by County 10 Map 2. Oil and Gas Revenue Distribution, by County 10

2 Investing in the Future Executive Summary

This report examines West Virginia’s severance tax, including how it is structured and how it functions, how the revenue it raises is invested, how severance taxes affect natural resource production and employment, and how changes to West Virginia’s economy will affect the severance tax. Key findings include:

• West Virginia ranked 7th nationally in reliance on • Studies in other states have shown that raising or severance tax revenue, with severance taxes making up lowering severance taxes has little effect on industry 9.0 percent of total state taxes in 2010. production and employment, while significantly affecting tax revenue. This may be due to the exportability of the • Coal production is by far West Virginia’s largest source severance tax and the overall low tax burden faced by the of severance tax revenue, but future projections show natural resource industries. natural gas quickly growing in importance. • The decline of coal and the boom in natural gas • West Virginia’s effective severance tax rate is lower than production creates an opportunity to use the severance most other natural resource-rich states that rely heavily tax in new ways, like the creation of a permanent trust on the severance tax. fund.

• West Virginia’s General Revenue Fund has grown more To strengthen the severance tax, West Virginia should reliant on severance tax revenue in recent years, with consider scaling back the credits, limits, and deductions severance tax revenue making up 11.1 percent of General available to the severance tax, which are rapidly growing Revenue funds in FY 2012. in size and scale. The state should also encourage local governments to use their share of severance tax revenue • Some severance tax revenue is distributed to local to invest in economic development and diversification, governments in West Virginia, where it is mainly used rather than just filling their budgets. Finally, the state at the local government’s discretion, usually for general should consider creating a permanent trust fund funded local government services and expenditures. Starting by severance tax revenue. The coming boom in natural gas in 2012, a portion of the coal severance tax will be development provides the state an opportunity to create a dedicated to economic development and infrastructure permanent source of wealth from a finite resource. projects in the coal-producing counties.

West Virginia Center on Budget & Policy 3 Introduction

West Virginia’s abundant natural resources not only have played an important role in West Virginia’s economy, they have also made important contributions to funding the state’s priorities. As a low-income state that is rich in natural resources, the revenue collected through the severance tax on resources like coal and natural gas plays an important role in funding education, health care, infrastructure, and other services provided at the state and local level in West Virginia.

Today, the severance tax is more relevant than ever. Severance tax revenue is a growing share of the state’s budget and provides more revenue to local governments each year. Meanwhile, the development of the Marcellus Shale and the booming natural gas industry will bring significant new revenue and opportunities for the severance tax.

However, while natural gas production booms, coal extraction, while the wealth generated flows away from production in West Virginia is declining. The state’s reliance where the resource was originally found. Instead, revenue on coal severance tax revenue could put it in a precarious from severance taxes is used to address the externalities of fiscal position in the future, if it were not for new severance resource extraction, like environmental reclamation and tax revenue from natural gas. This highlights the need for remediation, industry regulation, infrastructure repair and economic diversification and the opportunities available development. It also goes toward education, health care, and from the severance tax. local government support.

Many of the top severance tax-collecting states preserve Severance taxes provide a significant source of revenue for their natural resource wealth through severance tax-funded many resource-rich states, where extractive industries play trust funds. These trust funds not only act as a stable source an important role in the economy. A total of 38 states have of funding through the swings of the natural resource some type of severance tax, mostly imposed on coal, natural market and as a permanent source of revenue for after the gas, and oil. West Virginia is one of the top ten states most resource is gone, but they also act as economic development reliant on the severance tax for tax revenue, with nine and diversification tools. In Montana, for example, the Big percent of total state tax revenue coming from the severance Sky Economic Development Trust Fund program aids in tax (Table 1). The top severance tax states are all rich in the development of good-paying jobs and promotes long- coal, oil, gas, or all three. Alaska tops the list with over 74 term stable economic growth through grants financed by percent of state tax revenue coming from severance taxes. the fund. While state budgets across the country have experienced The severance tax is a tax on the privilege of severing or significant shortfalls in the past few years, due to the extracting natural resources, such as coal, natural gas, stagnant economy, rising energy prices have helped stabilize oil, timber, or other minerals. Severance taxes are usually the budgets of the top severance states, helping these states structured to tax either the gross value of the resource after avoid fiscal problems.1 And, as mentioned above, many it is extracted or the volume of production. Severance taxes of these states use their severance tax revenue to create allow communities and states to capture some of the wealth permanent trust funds which are used to diversify and generated by the extraction of natural resources, before the strengthen their economies. resource is depleted. Without a severance tax, communities would be left to deal with the direct costs of resource

4 Investing in the Future The coming boom in natural gas production presents an Section Three examines the impact of the severance tax opportunity for West Virginia to use its severance tax to and other state and local taxes on the affected industries, secure its financial future, and allows the severance tax to particularly coal and natural gas, with a review of severance be used to turn its natural resource wealth into long-term tax studies in other states, and explores several explanations growth and prosperity. for the severance tax’s small impact.

This report examines West Virginia’s severance tax, with a Section Four looks at the future of the severance tax focus on how it is used and its effects on the state’s finances, in West Virginia, with particular attention to projected as well as its effects on coal and natural gas production. changes in coal and natural gas production, and how those changes will impact the state’s finances. It also discusses how Section One provides a brief history of the severance tax severance taxes are distributed to local governments. in West Virginia, before exploring its current structure. It outlines structure and function of West Virginia’s severance tax, while also comparing it to other top severance tax collecting states.

Section Two explains how severance tax revenue is used in West Virginia, including its distribution at the state and local levels and future changes to that distribution. It also contains at closer examination at how local governments in West Virginia use their share of severance tax revenue.

TABLE 1 Top Severance Tax States, 2010 Rank State Total Tax Revenue Severance Tax Severance Tax as Revenue Share of Total 1 Alaska $4,518,023,000 $3,355,049,000 74.3% 2 North Dakota $2,645,695,000 $1,136,553,000 43.0% 3 Wyoming $2,117,100,000 $721,002,000 34.1% 4 New Mexico $4,413,988,000 $654,752,000 14.8% 5 Montana $2,142,809,000 $253,649,000 11.8% 6 Oklahoma $7,079,985,000 $743,686,000 10.5% 7 West Virginia $4,655,034,000 $417,230,000 9.0% 8 Louisiana $8,757,557,000 $758,469,000 8.7% 9 Texas $39,399,251,000 $1,737,136,000 4.4% 10 Kentucky $9,531,507,000 $317,146,000 3.3% Source: U.S. Census Bureau, 2010 Annual Survey of State Government Tax Collections.

West Virginia Center on Budget & Policy 5 Section One West Virginia’s Severance Tax

A severance tax in West Virginia was first proposed in 1953 by Governor William Marland. Governor Marland’s proposal would have levied a tax on the production of coal, oil, natural gas, sand, gravel, and limestone, and revenues from the tax would have been used to fund new schools and the construction of new roads.2 However, it was not until 1987 that a severance tax was implemented in West Virginia, with the passage of the West Virginia Severance Tax Act.

Before 1987, West Virginia’s State Business and Occupation or receivable by the taxpayer for the sale of the resource. Tax acted as a de facto severance tax. The tax was based on In the case of natural gas, “gross value” refers to the value gross receipts for every entity conducting business in West of natural gas at the wellhead, before it is transmitted or Virginia, making the sale of coal, natural gas, and other transported.6 resources subject to the tax. The Tax Reform Act of 1985 limited the tax to public utilities, electric power producers, FIGURE 1 and natural gas storage facility operators.3 Since then, the Sources of Severance Tax Revenue, FY 2011 severance tax has become an important source of revenue $600,000,000 for the state. $500,000,000 Today, West Virginia’s severance tax is imposed on the producers of any natural resource product, including rock, $400,000,000 Other* stone, limestone, coal, shale, gravel, sand, clay, natural gas, oil, and timber. The producer of the natural resource is the $300,000,000 Natural Gas one who has ownership of the natural resource immediately 4 $200,000,000 after it is severed or extracted. Coal

Revenue Sources for Severance Tax $100,000,000 Coal is unsurprisingly the largest source of severance tax $0 revenue of West Virginia’s natural resources, with nearly Source: West Virginia Dept of Revenue, Severance Tax Disaggregation FY 2011. 88 percent, over $449 million, of the state’s severance tax Note: Other includes timber, coalbed methane, sand, gravel, limestone, sandstone, waste coal. revenue (Figure 1). Natural gas is the second largest source, with $51 million in revenue, with the rest of West Virginia’s West Virginia also levies an additional severance tax on natural resources contributing roughly $10 million. coal (56 cents per ton), natural gas (4.7 cents per MCF), and timber (2.78 percent of gross value).7 The revenue from West Virginia’s severance tax is levied on the gross value this additional severance tax is deposited into the Workers’ of the resource produced in a given year, with a base rate Compensation Debt Reduction Fund in order to pay off the of five percent for all natural resources, except for timber.a unfunded liability of the Workers’ Compensation Old Fund. Timber is taxed at a rate of 1.22 percent, but the severance Once the unfunded liability is paid, the additional severance tax on timber has been temporarily eliminated.5 tax will be eliminated. Generally, the “gross value” of resource on which the severance tax is levied is defined as the amount received

6 Investing in the Future Severance Tax Rates TABLE 2 While West Virginia’s base rate of five percent is uniform West Virginia Statutory Severance Tax Rates for all natural resources, except for timber, there are several Natural Resource Tax Rate 5.0% (4.65% state, exemptions, limits, and deductions that lower the rate. Coal There are reduced severance tax rates for thin seam coal 0.35% local) Coal produced by underground produced from underground mines. Coal produced by 2.0% (1.65% state, mining methods from seams 37” to underground mines from seams 37 inches to 47 inches 0.35% local) 47” thick thick is taxed at a rate of two percent, while coal produced Coal produced by underground 1.0% (0.65% state, by underground mines from seams less than 37 inches thick mining methods from seams less 0.35% local) is taxed at a rate of one percent (Table 2). than 37” thick Waste coal 2.5% This thin seam tax preference has been growing in value Limestone or Sandstone 5.0% in recent years (Figure 2). In 2010, the value of the tax Oil and Natural Gas 5.0% reduced rate was nearly $75 million. More and more of Methane Gas 5.0% West Virginia’s coal production qualifies for the reduced Sand, gravel 5.0% rate, as the share of the total coal severance tax base that Timber 1.22% falls under the reduced rates has been rising steadily. In Timber produced in tax years 0.0% 2010, it was over 15 percent. 2010-2012 Other resources 5.0% Other reductions to the severance tax include an annual Source: West Virginia Code §11-13A. credit of $500 for all taxpayers subject to the severance tax, a credit for a qualified investment that results in the creation FIGURE 2 of new jobs, a credit for the revitalization of industrial facilities and for research for the development of the sales Value of Reduced Severance Tax Rate for Thin of natural resources, and a credit for the investment in coal Seam Coal $75.0 20% loading facilities.8

When taken together, these different reductions lower $62.5 the overall effective severance tax rate below the statutory 15% rate of five percent. In 2007, West Virginia collected $50.0 $328 million in severance taxes,9 while the total value of shipments and services in the mining industry (NAICS 211) $37.5 10% in West Virginia was $10.2 billion.10 This gives an effective

severance tax rate of 3.2 percent, 36 percent lower than the dollars of Millions $25.0 statutory rate of five percent. 5%

$12.5

$0.0 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Share of Coal Severance Tax Base

Value of Lower Rate

Source: West Virginia Department of Revenue, Presentation to FTA Revenue Estimation & Tax Research Conference, October 18, 2011.

West Virginia Center on Budget & Policy 7 Severance Taxes in Other States While West Virginia uses the gross value of the resource The top 10 severance tax states had an average effective when applying the severance tax, other states use different severance tax rate of 5.2 percent, higher than West Virginia’s methods. Some states apply the tax to production volume, effective rate of 3.2 percent. This means West Virginia has a while others use tiered tax rates based on the price of the lower effective severance tax rate than several other highly resource. The statutory rates, therefore, make comparisons productive energy resource states. between states difficult. Calculating an effective rate allows for comparisons to be made state to state (Table 3).

TABLE 3 Effective Severance Tax Rates for Top Severance States, 2007 Mining, Oil, and Gas Severance Tax Rank State Effective Rate Total Value Revenue 1 Alaska $21.7 billion $2.4 billion 11.2% 2 North Dakota $4.1 billion $391 million 9.6% 3 Montana $3.5 billion $264 million 7.5% 4 New Mexico $17.4 billion $942 million 5.4% 5 Kentucky $7.5 billion $275 million 3.6% 6 Wyoming $22.1 billion $803 million 3.6% 7 West Virginia $10.2 billion $328 million 3.2% 8 Oklahoma $34.2 billion $942 million 2.8% 9 Texas $101.9 billion $2.7 billion 2.7% 10 Louisiana $44.0 billion $904 million 2.1% Source: U.S. Census Bureau, 2007 Economic Census and 2007 Annual Survey of State Government Tax Collections.

Where the Severance Tax Is Invested FIGURE 3 West Virginia’s severance tax revenue is used for a variety of Severance Tax Distribution, FY 2011 purposes, both at the state and local level (Figure 3). Division of Local Forestry Dedication Tax Department (0.10%) (8.97%) Administration Infrastructure Fund Infrastructure (0.01%) The first $24 million collected from severance taxes each Fund year is deposited into the West Virginia Infrastructure (4.69%) Fund.11 Since the deposit is made from the first severance taxes paid, the amount deposited from taxes collected from any particular source depends on when the tax payment is made. In FY 2011, $22 million was deposited from coal severance taxes, and $1.7 million from natural gas.12

Tax Department Administration Each year, $70,000 of the revenue goes to the tax General department for the administration of the severance tax. This Revenue Fund amount comes equally from coal and natural gas.13 (86.23%)

Source: West Virginia Department of Revenue, Severance Tax Disaggregation FY 2011.

8 Investing in the Future Division of Forestry Severance tax revenue raised from timber is placed into a Revenue from either the County Coal Fund or the All special account and is appropriated by the Legislature for Counties and Municipalities Fund goes into a “Coal the Division of Forestry.14 Severance Tax Revenue Fund” created by each county and municipality. From there, the revenue can be used by the Local Dedication governing officials with little restriction, as described later. A significant amount of severance tax revenue is dedicated for local governments. The local government dedication During the First Special Session of the 2011 Legislative comes from coal and natural gas/oil severance tax revenue, Session, the West Virginia Legislature enacted a new law, and how it is distributed differs for each resource. dedicating more coal severance tax revenue to the coal- producing counties. Under the new law, five percent of coal Coal Local Dedication severance tax revenue, up to $20 million annually, will be The revenue raised through the severance tax rate of 0.35 distributed to the coal-producing counties. The five percent percent (which is included in the base five percent rate reallocation will be phased in over five years beginning in as well as the reduced rates for thin seam coal) on coal 2012, and will be accounted for after revenue dedicated to production is distributed quarterly to West Virginia’s other funds is distributed, including the County Coal Fund counties and municipalities in two different ways.15 In FY and the All Counties and Municipalities Fund.21 2011, that amounted to $37.7 million.16 The five percent of coal severance tax revenue will be First, 75 percent of the revenue collected for local deposited into a new fund, the “Coal County Reallocated dedication is placed into the “County Coal Revenue Fund” Severance Tax Fund,” and then distributed to the coal- and distributed to coal-producing counties. The amount producing counties, based on their share of total West each coal-producing county receives is determined by Virginia coal production. Each coal-producing county multiplying the percentage of total West Virginia coal will create a “(Name of County) Coal County Reallocated mined in that county by the total amount of money Severance Tax Fund” into which the distributions will be available in the fund.17 deposited. Revenue in this new fund is to be used solely for economic development and infrastructure projects.22 In FY 2011, $28.3 million was distributed to 29 of West Virginia’s counties through the County Coal Revenue Fund. Had this new dedication been fully in effect in FY 2011, it Boone County was the largest recipient, receiving $4.8 would have nearly doubled the amount of severance tax million, nearly 17 percent of the total.18 Map 1 shows the revenue dedicated solely to the coal-producing counties. distribution of the county coal fund. The coal-producing counties would have received $20 million from the new Coal County Reallocated Severance The remaining 25 percent of local dedication revenue is Tax Fund and $28 million from the County Coal Revenue placed into the “All Counties and Municipalities Fund” and fund, in addition to their share of the All Counties and is distributed quarterly to each county and municipality Municipalities Fund. in the state.19 The revenue from the All Counties and Municipalities Fund is distributed according to population.a In FY 2011 $9.4 million was distributed to local governments through the fund.20

a The amount distributed to individual local governments from the All Counties and Municipalities Fund is calculated in the following steps. 1) A county’s base share is calculated by multiplying the total amount in the fund by the county’s share of the state’s population. 2) The amount distributed to the county government is calculated by multiplying the county’s base share by the percentage of the county’s population living in its unincorporated areas. 3) The municipalities’ share of the county base share is calculated by multiplying the county base share by the percentage of the county’s population living in municipalities. 4) The amount distributed to each municipality is calculated by multiplying the municipality share by the percentage of the county’s total municipal population living in each municipality.

West Virginia Center on Budget & Policy 9 MAP 1 County Coal Revenue Fund Distribution FY 2011

County Coal Revenue Fund Received by County Does not receive funds Less than $100,000 $100,000 - $499,999 $500,000 - $999,999 $1,000,000 and more

Source: Data from State of West Virginia, Treasurer’s Office. Map created by Elizabeth Paulhus. MAP 2 Oil & Gas County Revenue Fund Distribution FY 2011

Oil and Gas Revenue Fund Received by County Does not receive funds Less than $10,000 $10,000 - $49,999 $50,000 - $99,999 $100,000 - 199,999 $200,000 and more

Source: Data from State of West Virginia, Treasurer’s Office. Map created by Elizabeth Paulhus.

10 Investing in the Future Oil and Gas Local Dedication Like coal, a portion of the severance tax collected from oil The distributions from both the Oil and Gas County and natural gas is dedicated to local governments. And like Revenue Fund and the All Counties and Municipalities coal severance revenue, the revenue is distributed first to the Oil and Gas Revenue Fund are deposited into the general oil- and gas-producing counties and then to all counties and revenue funds of the receiving local governments.27 municipalities in West Virginia. General Revenue Local governments receive 10 percent of oil and natural The remaining revenue collected from the severance tax gas severance tax revenue, of which 75 percent is deposited and not distributed to any other fund is deposited into into the “Oil and Gas County Revenue Fund.” Revenue is West Virginia’s General Revenue Fund. In FY 2011, $440.9 then distributed to the oil- and gas-producing counties million of severance tax revenue went into the state’s in West Virginia based on their share of total state oil and General Revenue Fund. This meant that 86.2 percent of gas production.23 In FY 2011, $4.6 million was distributed all severance tax revenue ended up in the state’s General through the Oil and Gas County Revenue Fund to 46 Revenue Fund.28 counties. Logan County was the largest recipient, receiving $344,697, or 7.5 percent of the total.24 Map 2 shows the For FY 2012, severance taxes provided over 11 percent of distribution of the Oil and Gas County Revenue Fund. the state’s General Revenue Fund, making it the third largest funding source, providing more revenue than the corporate The remaining 25 percent of the local dedication is net income and business franchise tax and the business and deposited into the “All Counties and Municipalities Oil and occupation tax combined (Figure 4). Gas Revenue Fund.”25 Revenue from this fund is distributed to all counties and municipalities in the state based on their The General Revenue Fund has grown more reliant on population.b In FY 2011 $1.5 million was distributed to severance tax revenue over time. Severance tax revenue local governments through this fund.26 made up an average of 5.5 percent of General Revenue from FY 1999 to FY 2005. Since then, severance tax revenue’s FIGURE 4 share of General Revenue has climbed to 11.1 percent Estimated General Revenue by Source, FY 2012 (Figure 5).29 Licenses, Permits, Other FIGURE 5 & Fees (3.93%) Other (0.23%) General Revenue Growing More Reliant on Taxes (5.83%) Severance Tax Revenue Corporate Net 12% Income & Business Consumer Sales & Use Tax Franchise Tax 10% (4.32%) (29.35%)

Severance 8% Tax (11.09%) 6%

B&O Tax Fund Revenue 4% as Share of General of Share as

(3.06%) Revenue Severance Tax

2% Personal Income Tax 0% (41.00%) 2000 2002 2004 2006 2008 2010 2012 Source: State of West Virginia Executive Budget FY 2012. Source: West Virginia Department of Revenue, Monthly Revenue Reports and FY 2012 Executive Budget Projections. b The amount distributed to local governments from this fund is determined using the same formula as the All Counties and Municipalities Coal Severance Fund distribution.

West Virginia Center on Budget & Policy 11 Section Two How the Severance Tax Is Invested

As the previous section described, the two largest beneficiaries of the severance tax in West Virginia are the General Revenue Fund and local governments. Through the General Revenue fund, the severance tax makes a significant contribution to funding the state’s public education system. In FY 2012, nearly half of the General Revenue Fund went to education (Figure 6). Other funding priorities for the General Revenue fund in FY 2012 include higher education, military affairs and public safety, and health and human resources.30

At the local level, severance tax revenue is used for a variety of purposes. For both coal and oil and gas revenue, the only restrictions on their use by local governments is that no more than 25 percent of the revenue can be budgeted for personnel services, and for the coal- and gas-producing counties with populations over 200,000, at least 75 percent of the county coal or oil and gas county revenues must be allocated to the resource producing areas of the county. Other than that restriction, local officials are free to use the severance tax revenue in what they believe is the best interest of the county or municipality.31

Natural Gas and Oil Local Use FIGURE 6 Counties and municipalities use their share of severance Estimated General Revenue Expenditures, FY taxes in a variety of ways. West Virginia’s county 2012 governments were budgeted to spend $3.6 million in Judicial Higher (3.00%) natural gas and oil severance tax revenue for FY 2011, Executive Education Legislature (1.18%) which includes the amount dedicated for the oil and gas (11.02%) (0.78%) Transportation Administration producing counties as well as the share dedicated to all local (0.18%) (1.81%) governments. County governments expended their oil and Revenue Commerce (0.75%) (1.67%) gas severance tax revenue on a range of categories, although the majority of the revenue went to general government expenditures (Table 4).32 This included funding the county commission, the county clerk, the prosecuting attorney, the sheriff, and the courthouse. Education (49.63%) TABLE 4 Health and Human Resour ces County Expenditures of Oil and Natural Gas (20.00%) Severance Tax Revenue, FY 2011 Education Number of and the Arts Expenditure Category Total Amount Counties (0.82%) General Government 52 $3,368,494 Source: State of West Virginia Executive Budget FY 2012. Public Safety 3 $280,000 Health and Sanitation 0 $0 Culture and Recreation 0 $0 Social Services 0 $0 Capital Projects 0 $0 Source: West Virginia State Auditor’s Office, County Budgets FY 2011-2012.

12 Investing in the Future West Virginia’s 231 municipalities were budgeted to spend TABLE 6 $640,678 in oil and natural gas severance tax revenue for County Expenditures of Coal Severance Tax FY 2011.33 Table 5 shows the categories of expenditures Revenue, FY 2011 toward which municipal governments budgeted their oil Number of Total Expenditure Category and gas severance tax revenue. Like county governments, Counties Amount municipalities in West Virginia overwhelmingly used this General Government 46 $15,904,845 revenue for general government expenditures, which often Public Safety 27 $8,139,806 includes funding the mayor’s office, the city clerk, the city Health and Sanitation 22 $5,426,351 attorney, city hall, the city manager, and public works Culture and Recreation 20 $3,272,050 departments. Social Services 14 $820,620 Capital Projects 15 $7,428,089 TABLE 5 Municipal Expenditures of Oil and Natural Gas TABLE 7 Severance Tax Revenue, FY 2011 Most Popular County Line Item Expenditures of Number of Total Expenditure Category Coal Severance Tax Revenue, FY 2011 Municipalities Amount Number of General Government 212 $575,580 Line Item Counties Public Safety 6 $49,212 County Commission 24 Streets and Transportation 14 $14,620 Courthouse 19 Health and Sanitation 1 $550 Economic Development 14 Culture and Recreation 0 $0 Library 12 Social Services 1 $216 Regional Jail 12 Capital Projects 1 $500 Local Health Department 11 Source: West Virginia State Auditor’s Office, Municipal Budgets FY 2011-2012. Other Buildings 11 Coal Local Use Dog Warden/Humane Society 10 West Virginia’s counties were budgeted to spend $41.0 Fire Department 10 million from their coal severance tax funds for FY 2011, Public Transit 10 which includes revenue dedicated to the coal-producing counties and revenue distributed to all counties, as well TABLE 8 as carryover balances from previous years.34 Most of Largest Line Item Total County Expenditures of the counties used their severance revenue for general Coal Severance Tax Revenue, FY 2011 government expenditures, like county commissions and Line Item Total Amount courthouses (Table 6). Half of the counties used part of Courthouse (Capital Projects) $4,932,415 their severance revenue on police, fire, and other public County Commission $4,337,154 safety expenditures. Regional Jail $3,745,153 Courthouse $3,177,606 Unlike natural gas and oil severance tax revenue, which is Water $2,348,869 deposited into local governments’ general revenue funds, Parks and Recreation $2,264,700 coal severance tax revenue is deposited into its own fund, Other Buildings $2,244,269 which allows for more detailed breakdown of expenditures Fire Department $1,317,620 by line item. Tables 7 and 8 list the most frequent line Transfer to Stabilization Fund $1,210,500 item expenditures, as well as the largest total line items for Garbage Department $1,004,000 county governments in FY 2011. Source for Tables 6-8: West Virginia State Auditor’s Office, County Budgets FY 2011-2012.

West Virginia Center on Budget & Policy 13 West Virginia’s 231 municipalities were budgeted to spend TABLE 10 $4.4 million from their coal severance tax revenue funds in Most Popular Municipal Line Item Expenditures FY 2011, which included carryover balances from previous of Coal Severance Tax Revenue, FY 2011 years.35 Table 9 shows the categories of expenditures Number of Line Item toward which municipal governments budgeted their coal Municipalities severance tax revenue. City Hall 90 Streets and Highways 62 Like for county governments, coal severance tax revenue Police Department 33 is deposited into its own fund for municipal governments, Parks and Recreation 23 allowing for a breakdown of expenditures by line item. Beautification 18 Tables 10 and 11 show the most frequent line items Library 14 expenditures, as well as the largest total line items for Street Lights 14 municipal governments in FY 2011. Fairs/Festivals 10 Fire Department 9 In 2012, when the new reallocation of severance tax revenue is in effect, the funds deposited in the Coal Snow Removal 9 County Reallocated Severance Tax Fund will be restricted for use on economic development and infrastructure TABLE 11 projects only, unlike the variety of uses for which the Largest Line Item Total Municipal Expenditures current local distribution of severance tax revenue is of Coal Severance Tax Revenue, FY 2011 allowed. These projects can include, but are not limited to, Line Item Total Amount commercial, industrial, and community improvement or Streets and Highways $781,278 preservation, post-mining land use, water or wastewater City Hall $773,218 facilities, storm water systems, steam, gas, telephone and Civic Center $521,637 telecommunication, broadband development, electric lines Police Department $312,439 and installation, roads, bridges, railroad spurs, drainage and Fire Department $241,210 flood control, industrial park development, or buildings Streets and Transportation that promote job creation and retention.36 $179,162 (Capital Projects) Finance Office $155,770 TABLE 9 Contributions/Transfers $151,900 Municipal Expenditures of Coal Severance Tax Revenue, FY 2011 City Manager’s Office $125,000 Street Construction $113,799 Number of Total Expenditure Category Source for Tables 10-11: West Virginia State Auditor’s Office, Municipal Budgets FY Municipalities Amount 2011-2012. General Government 123 $1,491,249 Public Safety 42 $579,332 Health and Sanitation 12 $58,592 Culture and Recreation 47 $718,888 Social Services 21 $113,185 Capital Projects 16 $292,581 Source: West Virginia State Auditor’s Office, Municipal Budgets FY 2011-2012.

14 Investing in the Future Section Three The Impact of Severance Taxes

Through the severance tax, West Virginia’s natural resource industries contribute hundreds of millions of dollars in revenue every year to the state’s finances. This is true for other natural resource-rich states, many of which rely on severance and other extraction taxes to a greater degree than West Virginia. However, many in the natural resource industry and in the policy community are concerned that their state tax policies may be hurting the industry, with higher taxes limiting production and costing their states jobs and economic development. Yet an examination of studies in several energy-producing states shows that tax rates, particularly severance rates, have little effect on energy production and that tax policy in general has little effect on the energy industry as a whole. Many of these concerns also overlook how severance tax revenue is put back into the economy.

Evaluation in Other States In 1999, the Wyoming Legislature funded an econometric severance tax rate reductions resulting in comparatively study of the effects of mineral tax incentives and tax small increases in production and comparatively large increases on the oil, gas and coal industries. For the oil reductions in severance tax collections.38 and gas industries, the study found that reductions in the severance tax rate resulted in a “tiny increase in drilling Another study requested by the Wyoming Legislature found activity over 60 years and virtually no change in production that the inverse was true as well; higher production taxes on activity,” while significantly reducing government revenue, the oil and gas industry were found to have little effect on even when increases in sales tax collections are included.37 production while substantially increasing revenue.39

A two percentage point reduction in the severance tax rate A more recent study performed for the Utah Tax Reform on oil and gas production increased total production by Commission in 2008 came to the same conclusions as only 0.68 percent over 60 years, while the present value of the studies in Wyoming. This study found that increasing severance tax revenue fell by more than 17 percent (Table severance taxes, through eliminating tax exemptions and 12). A reduced rate on new oil and gas production also credits for the oil and gas industry, would increase tax had a small impact on production, with a four percentage revenue while having only a small impact on oil and gas point reduction only increasing production by 1.66 percent industry activity.40 over 60 years, while revenue fell by more than 42 percent. The results were similar for the coal industry, with coal

TABLE 12 Simulated Tax Incentive Scenarios for Wyoming Severance Tax Change in Change in Present Tax Incentive Total Production Value of Severance (projected over 60 years) Tax Collections Reduce Severance Tax on Oil and Gas 0.68% -17.35% by two percentage points Reduce Severance Tax on New Oil and Gas Production 1.66% -42.84% by four percentage points Reduce Severance Tax on Coal 0.47% -27.0% by two percentage points Source: Shelby Gerking, et al, “Mineral Tax Incentives, Mineral Production and the Wyoming Economy.”

West Virginia Center on Budget & Policy 15 The issue of tax parity also has shown to have little effect a worst case scenario, in a loss of 8,624 man-days of labor, on the energy industry, as the experiences of Wyoming a loss of approximately 33 full-time jobs,d while bringing and Montana earlier this decade showed that different tax in $92 million in revenue.42 Baseline estimates indicate structures with dramatically different effective tax rates had that $35,000 of spending generates one job, making the little impact on the amount of investment in each state. employment impact of the severance tax a net positive.43

In the late 1990s, both Montana and Wyoming were The Impact of the Severance Tax Is Small experiencing a lull in energy production and exploration, There are several reasons why the impact on mineral and were looking for ways to jump-start their economies. In production is so small when a severance tax is applied. First, 2001, Montana’s legislature simplified its tax structure and the production in the extractive industry is driven mainly reduced its severance tax rate on oil and gas, and also added by the location of reserves. Other industries with more new incentives that nearly exempted new production from mobile capital have more flexibility to relocate their facilities production taxes. In contrast, Wyoming, in response to or choose where to start production. The natural resource the findings of the two studies mentioned above, canceled industries do not have this flexibility. Their decisions on a two percent reduction in its severance tax that had been where to produce are tied to where the resource is located, scheduled the previous year. As a result of these changes, regardless of tax burdens and various tax incentives. Other the overall effective tax rate faced by the oil and gas industry factors such as price, access to markets and infrastructure, 41 has about 50 percent higher in Wyoming than in Montana. like pipelines, and technology all have more significant effects on industry activity. Both states experienced a boom in the natural gas industry in the years after their tax changes, but Wyoming fared Another significant factor that decreases the impact of the much better (Table 13). Not only did Wyoming see a greater severance tax is their deductibility. Severance taxes are increase in production value, but state revenue increased deductible against federal corporate income tax liabilities. more as well. There is little evidence in the production and The federal corporate income tax rate is currently 35 revenue figures to suggest that the natural gas industry fled percent, meaning that for every $1 paid in severance taxes, Wyoming’s higher tax climate and moved to Montana. a firm’s federal corporate income tax liability falls by $0.35. This also partially offsets any benefit of decreasing the Other analyses have shown that the imposition of a severance tax, which would result in an increase in federal severance tax has little impact on employment. A 1985 Penn tax liabilities. State study found that a $2.00 per ton severance tax (an effective rate of roughly five percent)c would result, under

TABLE 13 Wyoming’s Higher Tax Climate Did Not Discourage Natural Gas Production Overall Effective Tax Rate Added Production Revenue Change State 2000 Tax Reform on Oil and Gas Production Value 2000-2006 2000-2006 Canceled severance tax Wyoming 15.9% $10 billion +335% reduction Reduced base severance rate; Montana 10.4% $2 billion +280% reduced rate on new production Source: Headwater Economics.

c According to the cited study, the price of Pennsylvania coal with no severance tax varied from $35.59 to $38.31 per short ton depending on destination. A $2.00 per ton severance tax would have an effective rate from 5.2 percent to 5.6 percent. d 8,624 man-days of labor translate into 68,992 man-hours. If each job is full-time, working 2,080 hours per year, 68,992 man-hours translate into 33.16 full time jobs.

16 Investing in the Future Overall, the natural resource extraction industries have FIGURE 7 below-average tax burdens. The coal, natural gas, and Natural Resource Industries Have Below- oil industries all had total effective tax rates (including Average Tax Burdens state, local, and federal taxes) below the market average Wholesale 37.0% for profitable firms (Figure 7). This is largely due to their preferential tax treatment, like the deductibility of the Medical Services 36.5% severance tax, and a variety of other tax subsidies that are Retail 32.5% available to the natural resource extraction industries. The capital-intensive nature of natural resource extraction Utilities 32.4% industries makes them eligible for a number of valuable tax Market Average 29.1% credits and deductions not available to other industries. Drug 28.5%

For example, Chesapeake Energy, an oil and natural gas Oil 26.6% firm with significant holdings in the Marcellus Shale, paid 25.7% no federal corporate income taxes in 2010, despite profits Chemical of $2.8 billion. From 2008 to 2010, Chesapeake Energy Natural Gas 24.9% paid an average effective federal corporate income tax rate of 8.1 percent, far below the statutory rate of 35 percent.44 Banks 24.5% This again is due to the variety of tax subsidies available to Coal 16.9% natural resource extracting companies, like the deductibility Source: Aswath Damodaran, NYU. of the severance tax. TABLE 14 In addition, overall, taxes are only a small part of the cost of High Business Taxes Not Related to High doing business, particularly in industries with a lower than Business Costs average tax burden, like coal, oil, and natural gas. According Overall State and Local Business States to the Council on State Taxation, West Virginia has the Business Tax Rate Cost Rank highest business tax burden of its neighboring states.45 But Maryland 4.0% 42 according to the Forbes business cost index, which is based Pennsylvania 4.6% 38 on the cost of labor, energy, and taxes, West Virginia has Alaska 13.8% 37 one of the lowest costs of doing business in the country, far lower than any of its border states (Table 14).46 West Ohio 5.1% 30 Virginia also has a lower cost of doing business than the Texas 4.9% 29 majority of energy states. New Mexico 5.9% 26 Montana 6.3% 23 Minor variations in wages, utilities, and transportation Virginia 3.5% 20 costs can have a greater impact than major changes in taxes. Kentucky 4.8% 16 Take West Virginia’s severance tax on coal for example. North Dakota 8.2% 6 In 2010, the coal industry paid $402 million in severance West Virginia 6.9% 4 taxes in West Virginia.47 In the same year, the industry paid Wyoming 9.7% 2 out $1.6 billion in wages to 20,476 workers (NAICS 2121 Source: Council on State Taxation and Forbes.com. coal mining), for an average hourly wage of $37.57.48 A 10 percent reduction in the coal severance tax ($40.2 million) would be more than offset by only a $1.00 average hourly wage increase ($42.6 million).

West Virginia Center on Budget & Policy 17 Who Really Pays the Severance Tax? FIGURE 8 Another reason for the small impact of the severance tax West Virginia’s Severance Tax Has No Obvious may be due to its incidence, or who actually pays the tax, Impact on Wage Growth

which is a subject of debate among tax scholars. Most 60% West Virginia scholars agree that severance taxes are highly exportable,

meaning that the burden of the tax falls on out-of- 50% state consuymers and stockholders of natural resource 49 companies. 40%

States with tax incidence models have confirmed the 30% exportability of their severance taxes. Texas’ tax incidence Pennsylvania model shows that more than half of its oil production tax is 20% exported,50 while Minnesota’s model found that 90 percent

of its severance tax on taconite is exported.51 2001 Since Wages Average 10% Growth in Oil and Gas Extraction Gas in Oil and Growth

While West Virginia does not have a tax incidence model, 0 its natural resources are heavily exported. According to the 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 West Virginia Division of Energy, approximately 90 percent -10% of coal and 57 percent of natural gas produced in West Source: Bureau of Labor Statistics, Quarterly Census of Employment and Wages. Virginia is exported.52

Not all scholars agree that the severance tax is exportable.53 What Is the Full Impact of the Severance Tax? Some scholars suggest that in a free market, the burden of The studies reviewed so far have shown that the severance the severance tax is solely borne by the in-state producer, tax has a very small impact on the production of natural resulting in lower wages for employees. However, there resources and a large impact on tax revenue. But that tax is little empirical evidence showing this, and as previous revenue also has its own impact. Any analysis of the impact sections have shown, natural resource industries do not of the severance tax that does not consider the impact of the operate in a free market and are, in fact, heavily subsidized revenue the tax creates is incomplete. In fact, any negative compared to other industries. impact the severance tax may have on employment, output, or income can be offset by the increased spending by state The experiences of Pennsylvania and West Virginia during and local governments that the severance tax revenue the recent boom in natural gas production cast doubt on the provides. assertion that the severance tax suppresses wages. Figure 8 compares average wage growth in the oil and natural The net positive impact of the severance tax was confirmed gas extraction industry (NAICS 211) in West Virginia and in a 2010 study from Penn State University. The study found Pennsylvania since 2001. As the figure shows, average wage that for every $100 million in severances taxes imposed on growth in West Virginia outpaced that in Pennsylvania oil and natural gas companies in Pennsylvania, the state almost every year, despite the lack of a severance tax in would see a net gain of 1,100 jobs, as well as a slight boost in Pennsylvania. gross state product.54

And as Section Two showed, West Virginia’s severance tax is used for a multitude of projects and services that create jobs and improve the economy, including infrastructure improvements, K-12 education, health care services, and economic development.

18 Investing in the Future Section Four The Future of West Virginia’s Severance Tax

Since its inception, coal has been West Virginia’s largest contributor to the severance tax. In FY 2011, severance tax revenue from coal accounted for almost 88 percent of all severance tax revenue. But projected changes to both coal and natural gas production will have a significant impact on the composition of West Virginia’s severance tax revenue.

The Declining Contribution of Coal, the Rising FIGURE 9 Contribution of Natural Gas Projected Decline of West Virginia Coal According to the U.S. Energy Information Administration, Production 150 coal production in Central Appalachia is projected to decline dramatically in the coming years, falling by 48.2 percent from 2010 to 2035. This will have a significant 120 impact on coal production in West Virginia, with historically about half of Central Appalachian production occurring in West Virginia. While production in Central 90 Appalachia is on the decline, production in Northern

Appalachia is projected to increase 16.4 percent between 60

2010 and 2035. However, West Virginia’s share of Northern Tons Short of Millions Appalachian production is much smaller, and Northern Appalachia is less productive overall, making its increase 30 not enough to offset the loss of Central Appalachian production (Figure 9).55 0 2010 2015 2020 2025 2030 2035 Source: WVCBP analysis of data from the U.S. Energy Information The coal production projections assume no new regulations Administration, AEO2011 National Energy Modeling System projections for will be adopted in the time frame. The adoption of a policy Northern and Central Appalachian production. such as cap and trade could alter the projections. FIGURE 10 While coal production in West Virginia is projected to Booming Natural Gas Production in West decline, natural gas production is projected to take off. In Virginia 1,200 fact, natural gas production in West Virginia could more than quadruple by 2035 (Figure 10). 1,000

800

600

Billions of Cubic Feet Cubic of Billions 400

200

0 2010 2015 2020 2025 2030 2035 Source: Downstream Strategies Analysis of data from the U.S. Energy Information Administration, AEO2011 National Energy Modeling System.

West Virginia Center on Budget & Policy 19 The Future Composition of the Severance Tax and natural gas severance taxes will impact this distribution The projected changes to natural gas and coal production in the future (Figure 12). will have a significant impact on West Virginia’s severance tax. Coal and natural gas are the two biggest sources of While coal production declines, the amount of revenue severance tax revenue for West Virginia, with coal as the dedicated to the coal-producing counties will actually largest by far. But with changes to coal and natural gas increase, as decreases in the County Coal Revenue Fund are production on the horizon, the make-up of West Virginia’s more than offset by the new revenue stream from the Coal severance tax will undergo major changes (Figure 11). County Reallocated Severance Tax Fund. In 2011, West

FIGURE 12 In FY 2011, severance tax revenue from coal was nearly nine times greater than severance tax revenue from natural Changes to Severance Tax Local Dedication gas, with $451.9 million from coal and $51.5 million from $80,000,000 natural gas. But by the early 2030s, their contributions will $70,000,000 be nearly equal, at about $300 million apiece. All Counties Municipalities $60,000,000 Oil and Gas Revenue Fund As coal production begins to decline, so will total severance Oil and Gas County tax revenue, as the increases in natural gas will not be $50,000,000 Revenue Fund enough to offset the losses from coal. Eventually, as coal $40,000,000 All Counties and production stabilizes and natural gas production continues Municipalities Fund (Coal) to rise, total severance tax revenue will rise as well. $30,000,000 Coal County Reallocated Severance Tax Fund These changes to the severance tax will be most noticeable $20,000,000 County Coal in the amount of severance tax revenue that is distributed Revenue Fund to local governments. As described in Section Two, a $10,000,000 portion of coal and natural gas severance tax revenue is $0 distributed to local governments, first to the counties where 2011 2035 Source: WVCBP Analysis of data from the U.S. Energy Information the resources were produced and then to all the county and Administration, AEO2011 National Energy Modeling System and the West municipal governments in the state. The changes in coal Virginia State Treasurer’s Office.

FIGURE 11 The Future of West Virginia’s Severance Tax $700,000

$600,000

$500,000 Total Natural Gas and Coal

$400,000 NETL Marcellus Shale

$300,000 Coal

Natural Gas (in thousands) $200,000 Severance Tax Revenue Revenue Severance Tax $100,000

0 2012 2015 2020 2025 2030 2035 Source: WVCBP and Downstream Strategies analysis of data from the U.S. Energy Information Administration, AEO2011 National Energy Modeling System, historical severance tax data from the WV Department of Revenue, and the National Energy Technology Laboratory. Note: Figure 11 also shows natural gas severance tax revenue projections in selected years from the Marcellus Shale. These projections are from: National Energy Technology Laboratory (NETL), “Projecting the Economic Impact of Marcellus Shale Gas Development in West Virginia: A Preliminary Analysis Using Publicly Available Data,” U.S. Department of Energy, March 31, 2010. The NETL projections for Marcellus Shale gas are higher than the more conservative projections for all natural gas.

20 Investing in the Future Virginia’s coal-producing counties split $28.3 million from By 2035 that amount is projected to more than quintuple, the County Coal Revenue Fund. In 2035, projections show to $23.9 million. The same is true for the All Counties that the coal-producing counties will split $37.7 million, and Municipalities Oil and Gas Revenue Fund, which is with $17.7 million coming out of the County Coal Revenue projected to grow from $1.5 million in 2011 to $7.9 million Fund and $20 million out of the Coal County Reallocated in 2035. Severance Tax Fund. In the final analysis, the real winners of the projected The coal severance tax revenue distributed to all of West changes to the severance tax are the natural gas-producing Virginia’s counties and municipalities will be directly counties, which will see their share of revenue substantially affected by declining coal production. While declines grow in the coming years. On the other hand, there are no in the distribution to the coal-producing counties from real losers with the coming changes. The revenue losses the County Coal Revenue Fund will be offset by new from declining coal production will be offset, first by the distributions from the Coal County Reallocated Severance new Coal County Reallocated Severance Tax Fund, which Tax Fund, there is no new distribution to offset the decline will go into effect in 2012, and the increases in natural gas in the All Counties and Municipalities Fund. In 2011, $9.4 revenue that is distributed to all local governments coming million in coal severance tax revenue was distributed from from increased natural gas production. These changes will the All Counties and Municipalities Fund. By 2035, that increase the amount of coal and natural gas severance tax amount is projected to fall to $5.9 million. revenue received by local governments in the future, from a total of $43.8 million in 2011 to $75.6 million in 2035. In contrast to the declines in coal revenue, the amount of natural gas severance tax revenue distributed to local governments is projected to grow substantially. In 2011, $4.6 million was distributed to the natural gas-producing counties through the Oil and Gas County Revenue Fund.

West Virginia Center on Budget & Policy 21 Section Five Conclusion

West Virginia’s natural resources are one of its greatest assets and an important source of wealth. But the extraction of those resources can come at a heavy price, creating stress on the environment, infrastructure, and local communities. Like many other natural resource-rich states, West Virginia levies a severance tax on the extraction of its natural resources. The revenue from the severance tax allows the state to capture natural resource wealth and use it for important purposes like education, infrastructure, health care, and countless other priorities for the state, as well as providing a way for the state to bear the costs imposed by natural resource extraction.

While the severance tax is levied on natural resource production is projected to sharply decline in the coming production in the state, evidence from other states suggest years, decreasing the amount of revenue brought in by that the tax is exported and paid by out-of-state consumers. the coal severance tax. Fortunately, the decline of coal in This allows West Virginians to enjoy the benefits provided West Virginia corresponds with a boom in natural gas by the revenue without bearing the actual burden of the tax. production. In the coming years, natural gas will grow from In addition, research shows that the severance tax is not a a relatively minor source of severance tax revenue to the large burden on industry, having little effect on production state’s largest source. and industry location. In order for West Virginia to benefit more fully from its Historically, coal has been the dominant source of severance natural resources, the state should consider policy changes tax revenue in West Virginia. However, West Virginia’s coal surrounding its severance tax.

Policy Recommendations • Consider scaling back severance tax credits, limits, and deductions. West Virginia’s effective severance tax rate is far below the statutory rate of five percent due to a number of credits, limits, and deductions available against the severance tax. In particular, the reduced rate for thin-seam coal production is rapidly growing in size and value. The effectiveness of these policies should be examined to determine if the goals of the policies are being meant and if the cost is acceptable. This is more important as tax policies like the reduced rate for thin-seam coal grow more expensive even as coal severance tax revenue declines and coal prices escalate.

• Encourage local governments to make a better effort to diversify their economies. Currently, most severance tax revenue distributed to local governments is used to fill budgets and provide basic services. The new allocation for coal-producing counties is a step in the right direction, with its funds directed towards economic development. Local governments should do more than use their share to pay for basic local government purposes. Local governments should use their revenue share to make investments that lead to greater economic diversification and growth, and should break their dependence on a volatile revenue source for the provision of basic services.

• Create a permanent trust fund. The coming boom in natural gas production provides West Virginia with an opportunity to convert its depleting natural resources into a permanent source of wealth. West Virginia should join states like Alaska, Montana, New Mexico, North Dakota, Utah, and Wyoming and establish a permanent trust fund based on a portion of severance tax revenue. In fact, the state could actually raise the effective rate of the severance tax in order to finance the trust fund with little risk of affecting the state’s natural resource industries.

22 Investing in the Future Endnotes

1 Mark Snead, “Are Energy States Still Energy States?” Federal Reserve Bank of Kansas City, 2009.

2 West Virginia Division of Culture and History, 1978.

3 Robin Capehart, et al, “Recommendations to the Governor,” The Governor’s Commission on Fair Taxation, The State of West Virginia, December 1999.

4 West Virginia Code §11-13A.

5 West Virginia Code §11-13A-3A, 11-13A-3a, 11-13A-3c, 11-13A-3d, and 11-13A-3e.

6 West Virginia Code §11-13A-2.

7 West Virginia Code §11-13V-1.

8 West Virginia Code §11-13A-10; 11-13C-1; 11-13D-1; 11-13E-1.

9 U.S. Census Bureau, 2007 Annual Survey of State Government Tax Collections.

10 U.S. Census Bureau, 2007 Economic Census.

11 West Virginia Code §31-15A-16.

12 West Virginia Department of Revenue, Severance Tax Disaggregation FY 2011.

13 West Virginia Code §11-13A-5 and §11-13A-6.

14 West Virginia Code §11-13A-20a.

15 West Virginia Code §11-13A-6.

16 West Virginia Department of Revenue, Severance Tax Disaggregation FY 2011.

17 West Virginia Code §11-13A-6.

18 West Virginia State Treasurer’s Office, Coal Severance Tax Distributions.

19 West Virginia Code §11-13A-6.

20 West Virginia State Treasurer’s Office, Coal Severance Tax Distributions.

21 West Virginia Legislature, 2011 1st Special Session, Senate Bill No. 1002 – Final Version.

22 Ibid.

23 West Virginia Code §11-13A-5a.

24 West Virginia State Treasurer’s Office, Oil and Gas Severance Tax Distributions.

25 West Virginia Code §11-13A-5a.

26 West Virginia State Treasurer’s Office, Oil and Gas Severance Tax Distributions.

27 West Virginia Code §11-13A-5a.

28 West Virginia Department of Revenue, Severance Tax Disaggregation FY 2011.

29 West Virginia Department of Revenue, Monthly Revenue Reports.

West Virginia Center on Budget & Policy 23 30 State of West Virginia Executive Budget FY 2012.

31 West Virginia Code §11-13A-5a and §11-13A-6.

32 West Virginia State Auditor’s Office, County Budgets 2011-2012 Fiscal Year.

33 West Virginia State Auditor’s Office, Municipal Budgets 2011-2012 Fiscal Year.

34 West Virginia State Auditor’s Office, County Budgets 2011-2012 Fiscal Year.

35 West Virginia State Auditor’s Office, Municipal Budgets 2011-2012 Fiscal Year.

36 West Virginia Legislature, 2011 1st Special Session, Senate Bill No. 1002 – Final Version.

37 Shelby Gerking, William Morgan, Mitch Kunce, and Joe Kerkvliet, “Mineral Tax Incentives, Mineral Production and the Wyoming Economy” (report prepared for the Mineral Tax Incentives Subcommitee, Wyoming State legislature, December 2000).

38 Ibid.

39 Mitch Kunce, Shelby Gerking, William Morgan, and Ryan Maddux, “State Taxation, Exploration, and Production in the U.S. Oil Industry” (report prepared for the Wyoming State Legislature, November 2001).

40 Gabriel Lozada and Michael Hogue, “The Effect of Proposed 2009 Tax Changes on Utah’s Oil and Gas Industry” (report prepared for the Utah Tax Review Commission, December 18, 2008).

41 Headwaters Economics, “Energy Revenue in the Intermountain West,” October 2008.

42 Jill Findeis and James Shortle, “Trade-offs Between Severance Tax Revenues and Coal Mining Employment,” Northeastern Journal of Agricultural and Resource Economics 14 (1985), 2.

43 Daniel Shoag, “The Impact of Government Spending Shocks: Evidence on the Multiplier from State Pension Plan Returns,” Harvard University Department of Economics, 2011.

44 Robert McIntyre, Matthew Gardner, Rebecca Wilkins, and Richard Phillips, “Corporate Taxpayers & Corporate Tax Dodgers 2008-10,” Citizens for Tax Justice & the Institute on Taxation and Economic Policy, November 2011.

45 Andrew Phillips, Robert Cline, Thomas Neubig, and Julia Thayne, “Total state and local business taxes State-by-state estimates for fiscal year 2009,” Council on State Taxation, March 2010.

46 Forbes.com, “Table: The Best States for Business,” http://www.forbes.com/2009/09/23/best-states-for-business-beltway-best-states_table.html.

47 West Virginia Department of Revenue, Severance Tax Disaggregation FY 2010.

48 Workforce West Virginia, Employment and Wages 2010.

49 Robert Tannenwald, “Fiscal Disparity Among the States Revisited,” New England Economic Review, July/August 1998, pp.7. and Mark Robyn and Gerald Prante, “State-Local Tax Burden Falls in 2009 as Tax Revenues Shrink Faster than Income,” Tax Foundation, February 2011, pp.68.

50 Susan Combs, “Tax Exemptions & Tax Incidence: A report to the Governor and the 82 Texas Legislature,” February 2011, pp.68.

51 “2011 Minnesota Tax Incidence Study: An Analysis of Minnesota’s Household and Business Taxes,” Minnesota Department of Revenue, Tax Research Division, March 15, 2011, p.100.

52 See: http://marshall.edu/cber/research/WVEF-2009.jpg.

53 W. Hildreth and James Richardson, Handbook on Taxation (New York: Marcel Dekker, 1999), pp. 227-236 and, James Richardson, “Severance Tax, State,” in The Encyclopedia of Taxation & Tax Policy, (Washington, D.C.: The Urban Institute Press, 2005).

54 Rose M. Baker and David L. Passmore, “Benchmarks for Assessing the Potential Impact of a Natural Gas Severance Tax on the Pennsylvania Economy,” Penn State Institute for Research in Training & Development, September 2010.

55 U.S. Energy Information Administration, AEO2011 National Energy Modeling System.

24 Investing in the Future Working Toward a Shared Prosperity

The West Virginia Center on Budget and Policy is a policy research organization that is nonpartisan, nonprofit, and statewide. It focuses on how policy decisions affect all West Virginians, including low- and moderate-income families, other vulnerable populations, and the important community programs that serve them.

723 Kanawha Blvd, Suite 300 Charleston, WV 25301 Tel: 304.720.8682 Fax: 304.720.9696 www.wvpolicy.org